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The National Development and Reform Commission (NDRC) yesterday decided to increase the electricity tariff for non-domestic uses according to Xinhua. Industrial, commercial and agricultural users will have to pay more in 15 provinces, while the rate for residential users remains unchanged.

This move makes sense. As previously mentioned, one of the big problems for China electricity production is that the coal prices have been rising while power rates are essentially fixed by the government, such that many power plants were operating at losses. As a result, they are not quite willing to produce enough power in order to limit losses. Now that the NDRC allows power rates to rise, that is a logical thing to do.

On the other side, the drought in the Yantze River region is getting more serious. Dongting Lake, for instance, is now becoming a grassland. Logistics is also affected as the rivers and lakes have not enough water for bigger boats to pass through. The fear now is that food production will be affected if the drought continues for any longer as 104.4 million mu of agricultural land is affected by droughts.

Both will increase inflationary pressure, particularly food prices inflation. Now the situation is getting quite challenging indeed. The economy is definitely slowing, but inflationary pressure is not easing as much as one would hope, and the drought is only adding fuel to the inflation.

I suspect that inflation will remain high for the coming 2 – 3 months, and I would not be surprised if the year-on-year headline inflation reaches 6% at some point in the near-future. The People’s Bank of China should maintain the policy stance for now, raising interest rates and reserve requirement ratios for 1 or 2 times in the coming months before any chance of stopping or easing. One may well say in a Bernankesque way that inflation is “transitory”, so I am maintaining my judgment that inflation in China will be less of a problem towards the end of this year.